Tuesday, July 28, 2009

Reader Saku tipped me on an interesting merger arbitrage opportunity, which has a large spread for arbitrageurs. In essence, AT&T (T) is acquiring Centennial Communications (CYCL) for $8.50/share, which was announced back in November 2008. The acquisition has been approved by Centennial's stockholders in February 2009 and remains subject to approval by the Department of Justice and Federal Communications Commission and other customary closing conditions. Once the transaction is complete AT&T would sell some assets in Louisiana and Mississippi to Verizon (VZ) for $240 million. If the merger between CYCL and AT&T occurs as planned, the sale of the assets to Verizon would close by 4Q 2009. The deal was expected to enhance AT&T's (T) coverage in Puerto Rico, the US Virgin Islands in addition to the rural Midwest.

Centennial Communications Corp. (Centennial) is a regional wireless and broadband telecommunications service provider serving over 1.1 million wireless customers and approximately 582,200 access line equivalents in markets covering approximately 13 million Net Pops in the United States and Puerto Rico. In the United States, it is a regional wireless service provider in small cities and rural areas in two geographic clusters covering parts of six states in the Midwest and Southeast.

Up until July 13, in 2009 Centennial Communication (CYCL) traded at a small discount of 1% to 5% to the $8.50 offer price. In February 2009, John Paulson showed a 5,000,000-share position in Centennial (CYCL) in his funds 13-F filing with the SEC.Back on July 8, AT&T announced that it expects to close the deal by the third quarter, because of added regulatory scrutiny. On July 14 however, the stock dropped 9.50% on above average volumes. Currently the stock is trading at $7.38, which is a 13.1% discount to the offer price. What might have been the reasons for this drop?

I found an interesting article from Bloomberg, explaining the reason for the drop: (source)

“Stifel Nicolaus & Co. said the carriers may have to review the terms of the deal. The U.S. Justice Department and the Federal Communications Commission are scrutinizing the transaction. The combined company would control 40 percent of Puerto Rico’s wireless market, which may prompt regulators to force AT&T to divest some assets, Stifel analyst Christopher King said today in an interview. Selling the Puerto Rican wireless business, which accounts for about a third of Centennial’s revenue, may cause AT&T to cut its offer, he said. “We’re clearly in a different antitrust environment,” said King, who is based in Baltimore. “This is certainly the first significant opportunity that the Obama administration will have had in the telecom sector to lay down the law.”AT&T hasn’t been asked to divest assets in Puerto Rico, said McCall Butler, a spokeswoman. Steve Kunszabo, director of investor relations for Centennial, didn’t immediately return a call seeking comment.AT&T, the second-biggest U.S. wireless carrier, and Verizon Communications Inc., its larger rival, swapped assets in May to appease concerns that AT&T’s Centennial purchase would hurt competition.”

While I agree that regulatory challenges are tough to predict, I believe that the small size of Centennial Communications (CYCL) could allow the merger to go through and close by the end of 2009. The problem with Puerto Rico is that it is viewed as a separate US territory, which is considered by regulators as somewhat between a colony and an independent state. Thus, Centennials 33%-40% share of the market there, in addition to AT&T’s market share could require more flexibility for the two carriers when dealing with regulators. The Puerto Rico wireless market is highly competitive however. In Puerto Rico, Centennial competes with five other wireless carriers: America Movil, AT&T Mobility, Open Mobile, Sprint Nextel, and T-Mobile. Thus, AT&T might have to sell other assets in order to appeal to regulators, in order for the deal to go through. I doubt that this would affect the offer price for Centennial Communications (CYCL).

I do believe that AT&T (T) would eventually acquire Centennial Communications (CYCL) at the price, agreed upon in 2008. At current levels of $7.38, the upside is 15.2%. If the deal falls through however, shares of the acquired company would most likely drop to $4. I would put a limit order for a small position in CYCL. It is important not to bet the farm on merger arbitrage opportunities. One of the reasons for the decline in the stock price could also be quick-tempered overleveraged arbitrageurs closing their positions in order to avoid margin calls, which happened with Anheuser Busch and Constellation Energy (CEG) deals.

In the best case I would be looking for a partial exit at somewhere above $8.20 and would evaluate my options later on.

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